We've bought and held for many years without too much angst and went with the big 3 Boglehead ETFs (VTI, BNS, VXUS) a few years ago.Simple.

But nobody is getting any younger or less risk adverse and I thought it would help my spouse to know ahead of time about bear markets and to mock up what the portfolio would look like if the stock prices dropped 30%. He had health issues for the last bear market and wasn't paying any attention; he completely missed it.

In my mockup, I left the bond price alone. Is that a reasonable assumption?

I think my mockup has accomplished the goal, to doublecheck comfort level; but I was surprised that I wouldn't really need to rebalance. I would still be within our goal AA +/- 5%. I had expected to be buying if there was a 30% drop in price. But maybe I would be buying if bond prices change in a bear market.

What would be a few reasonable assumptions for BND price to play around with in my mock up?

Thank you all you Bogleheads - the portfolio is working and everyone is sleeping at night.

I think that your assumption that BND will not change (much) is very reasonable. The last bear market was driven by the financial crisis, which affected the debt markets. Normally I would expect bond to move less than 3%-5% (either way).

For a 30% drop in stocks (and no change in bonds) not to trigger rebalancing with a +/-5 percentage point band, your target stock allocation must be above about 85% or below about 20%. Here's a good article on the topic with math and charts: +/- 5% Rebalancing Bands.

Historically, high quality bonds average out to be roughly uncorrelated with stocks (though this has shifted over time with both + correlation and - correlation regimes, by more than you would expect from noise/randomness), so a naive, first-level assumption would be that "no change" is reasonable. That said, recently safe bonds have been negatively correlated with stocks, and in the last bear market and in some prior, there has been a flight-to-quality aspect and high quality bonds actually gained.

That's just the past, though. In any given twelve months, not just looking at calendar years like Vanguard did above and for nominal returns, things could definitely be worse.

In general the causes of equity bear markets contain some commonalities but each is unique so you can't accurately predict how that will translate in the bond market.

With the understanding that stocks can definitely do worse than 30%, realize that bonds could also do worse than a couple standard deviations down, which might look something like that -8% given starting yields today. In nominal terms. Presumably if interest rates really spiked, it would be in response to higher inflation.

You can pretty much do it in your head if assuming no change in bonds. Multiply percent drop in stock by percent allocation to stocks for total portfolio percent drop. So at 70% stocks, a 30% drop in stocks is a 21% drop in portfolio.

For rebalancing, say you start with $70 in stocks and $30 in bonds. A 30% drop in stocks means you have 70% of stock value left so $49 in stocks, which I'll round to $50, so now $50 in stocks and $30 in bonds. Total portfolio now is $80, so 5/8 stock and 3/8 bonds. So that's about 62.5% stocks and 37.5% bonds. These are more than 5 percentage points from targets, so you would rebalance if using +/- 5pp band. You actually would have rebalanced before this.

Of course you can do multiple scenarios like this easily with a spreadsheet.

Kevin M wrote:You can pretty much do it in your head if assuming no change in bonds. Multiply percent drop in stock by percent allocation to stocks for total portfolio percent drop. So at 70% stocks, a 30% drop in stocks is a 21% drop in portfolio.

Yes.

Given that you can't predict how much a bear market will decline or how long it will stay down, it doesn't make sense to be more precise than that. (People sometimes forget that the quick recovery after 2008-2009 was not foreordained, and it even surprised people. People didn't believe it was real, kept talking about the possibility of an "L-shaped recovery," and called the rise a "dead cat bounce" and a "value trap" luring investors in only to disappoint them with another crash).

Now, if we look at 2008-2009, stocks dropped about 50%, so, using Kevin M's rule, one would expect LifeStrategy Growth, Moderate Growth, Conservative Growth, and Income to have dropped about 50%-of-80%, 50%-of-60%, 50%-of-40%, and 50%-of-20%--i.e.

40%, 30%, 20%, and 10%

respectively. (They actually allocations may not have been exactly 80%, 60%, 40%, and 20% because at the time those funds were still doing tactical asset allocation, but this should all be ballpark anyway). The actual numbers, starting from 12/31/2007 to bottom at 3/6/2009, were:

49%, 39%, 29%, and 17% respectively.

So the rule of thumb isn't too bad.

I think they fell more than the rule of thumb for the following reasons, but it's not important to go down that rabbit hole even though I can't resist it.1) Total Stock dropped 53%, a bit more than the 50% I used in my mental math.2) It's my belief that the tactical asset allocation component, VAAPX, was up to 100% stocks at that point and thus they were probably all over their "neutral" allocation.3) The LifeStrategy funds all have an international stock component, and international stocks fell more than the US stock market.

And, most interesting, but there's another small factor, which I saw in VBINX, which was 60% stocks but fell 34% instead of 53%-of-60% = 32%, and that's the effect of continuous rebalancing, which on the way down is constantly throwing good money after bad and thus making the declines slightly greater than if there had been no rebalancing.

If the goal is a sanity check on the risk management designed into one's asset allocation, it would probably be better to use a downturn of at least 50% for equities. A 30% drop is in the ballpark for less than half of the bear markets of the last 100 years.

nisiprius wrote:. . . . . . . . And, most interesting, but there's another small factor, which I saw in VBINX, which was 60% stocks but fell 34% instead of 53%-of-60% = 32%, and that's the effect of continuous rebalancing, which on the way down is constantly throwing good money after bad and thus making the declines slightly greater than if there had been no rebalancing.[/size][/color]

1 Doesn't this make a strong argument for rebalancing in "bands" ie: 5% or other tolerance. . . (to prevent throwing good money after bad)?

2 The idea of "throwing good money after bad" in a declining market via "rebalancing" is something I've thought about. What is the solution?

nisiprius wrote:. . . . . . . . And, most interesting, but there's another small factor, which I saw in VBINX, which was 60% stocks but fell 34% instead of 53%-of-60% = 32%, and that's the effect of continuous rebalancing, which on the way down is constantly throwing good money after bad and thus making the declines slightly greater than if there had been no rebalancing.[/size][/color]

1 Doesn't this make a strong argument for rebalancing in "bands" ie: 5% or other tolerance. . . (to prevent throwing good money after bad)?

2 The idea of "throwing good money after bad" in a declining market via "rebalancing" is something I've thought about. What is the solution?

3 If so, why rebalance at all?

Thanks as always for your educated input and lessons.j

Have there been any studies based on using timing models to rebalance? Like only rebuy into stocks after TI is above its 200-day moving average, or some similar approach?

ghudson wrote:...Have there been any studies based on using timing models to rebalance? Like only rebuy into stocks after TI is above its 200-day moving average, or some similar approach?

Sandtrap wrote:

nisiprius wrote:...And, most interesting, but there's another small factor, which I saw in VBINX, which was 60% stocks but fell 34% instead of 53%-of-60% = 32%, and that's the effect of continuous rebalancing, [color=#0040FF]which on the way down is constantly throwing good money after bad and thus making the declines slightly greater than if there had been no rebalancing...

1 Doesn't this make a strong argument for rebalancing in "bands" ie: 5% or other tolerance. . . (to prevent throwing good money after bad)? 2 The idea of "throwing good money after bad" in a declining market via "rebalancing" is something I've thought about. What is the solution? 3 If so, why rebalance at all?

First of all, in a balanced fund, you don't get to decide how rebalancing is done. They do it for you, essentially continuously, and what happens, happens. So it doesn't really matter what would happen with alternative rebalancing strategies.

Second, the effect I'm talking about is there, but it is not big or serious.

Third, it slightly magnifies losses on the way down, but it slightly magnifies gains on the way up, during which maintaining a stable asset allocation requires you to be constantly selling appreciating stock. You are throwing good money after bad on the way down, but on the way up all the bad money turns good and comes back to you.

As for alternative strategies, rebalancing is most-discussed topics in Bogleheads. I will articulate some of the questions without answering them. 1) Is rebalancing just something you do occasionally so that your portfolio doesn't drift until it becomes unsuitable for your risk tolerance, or is it an important contributor to portfolio performance? 2) Is there a "rebalancing bonus," extra return that is generated by rebalancing? 3) If there is a rebalancing bonus, does it only occur as a result of assets showing "mean reversion," or can rebalancing actually manufacture extra return out of pure volatility? 4) How strong, reliable, or predictable is mean reversion? 5) If the rebalancing bonus results from mean reversion, can rebalancing strategies be tuned to match the time dynamics of mean reversion to get as big a rebalancing bonus as possible? 6) Is rebalancing just a mild form of market timing? 7) Is rebalancing a form of market timing that actually works? (My own answer to #1 is yes, and therefore my answers to the rest don't matter to me).

ghudson wrote:...Have there been any studies based on using timing models to rebalance? Like only rebuy into stocks after TI is above its 200-day moving average, or some similar approach?

Sandtrap wrote:

nisiprius wrote:...And, most interesting, but there's another small factor, which I saw in VBINX, which was 60% stocks but fell 34% instead of 53%-of-60% = 32%, and that's the effect of continuous rebalancing, [color=#0040FF]which on the way down is constantly throwing good money after bad and thus making the declines slightly greater than if there had been no rebalancing...

1 Doesn't this make a strong argument for rebalancing in "bands" ie: 5% or other tolerance. . . (to prevent throwing good money after bad)? 2 The idea of "throwing good money after bad" in a declining market via "rebalancing" is something I've thought about. What is the solution? 3 If so, why rebalance at all?

First of all, in a balanced fund, you don't get to decide how rebalancing is done. They do it for you, essentially continuously, and what happens, happens. So it doesn't really matter what would happen with alternative rebalancing strategies.

Second, the effect I'm talking about is there, but it is not big or serious.

Third, it slightly magnifies losses on the way down, but it slightly magnifies gains on the way up, during which maintaining a stable asset allocation requires you to be constantly selling appreciating stock. You are throwing good money after bad on the way down, but on the way up all the bad money turns good and comes back to you.

Maybe I got lost somewhere, but I think you have that backwards. As you say, when stocks are trending down then constant rebalancing into stocks hurts relative to letting percentages float a bit. But if stocks are trending up, then constant rebalancing out of stocks also hurts relative to letting the higher stock allocations ride out. After all, you want the higher stock allocations relative to target during an uptrend, and lower stock allocations relative to target during a downtrend.

Hence if there are strong trends then some kind of rebalancing based on a trend-following kind of overlay/stat like 200-MA cross would help.

The problem is that there aren't consistent trends all the time. It's going to help sometimes and hurt other times. On average, over long periods of time... well, I haven't checked the data myself, but even if I have, I wouldn't be terribly confident in the historical better approach to persist. I suspect you'd get a slight net positive on average.

It may be hard to make a financial argument for using a fund with rebalancing characteristics. But from a practical sense one can make a strong argument. The majority of people cannot control their emotions well enough in downdrafts to buy when it is advantageous. This is one of the reasons why so many people have individual performance numbers that badly trail the market and/Or fund performance numbers. I am a strong believer in using something like the life strategy funds. Just set it and forget it. Maximize convenience and minimize worry. Never have to ask oneself should I buy today or could I do better by waiting until next week.

No one can predict the future consistently. Every time we as humans take the reins we are opening ourselves up to the possibility of under performance.

I'm not a fan of BND - it has more risk and offers a pretty small potential yield improvement vs what I can achieve myself as a retail investor.

Depending on what is driving the bear market it could see a continued selloff. You have 15% BBB, 12% A rated bonds, 8.3 year maturity, 6 year duration and only a 2.5% SEC Yield. Right now I can buy 2.3% 5 year Wells Fargo CDs or 2.35% 5 year JPM (not call protected, but in a bear market getting bought out early is a nice thing) that offer 100% principal protection - so why go with BND is principal protection is the goal?

I just buy CDs and Short-Term Treasuries to make up 100% of my FI allocation.

nisiprius wrote:. . . . . . . . And, most interesting, but there's another small factor, which I saw in VBINX, which was 60% stocks but fell 34% instead of 53%-of-60% = 32%, and that's the effect of continuous rebalancing, which on the way down is constantly throwing good money after bad and thus making the declines slightly greater than if there had been no rebalancing.[/size][/color]

1 Doesn't this make a strong argument for rebalancing in "bands" ie: 5% or other tolerance. . . (to prevent throwing good money after bad)?

2 The idea of "throwing good money after bad" in a declining market via "rebalancing" is something I've thought about. What is the solution?

3 If so, why rebalance at all?

Thanks as always for your educated input and lessons.j

Have there been any studies based on using timing models to rebalance? Like only rebuy into stocks after TI is above its 200-day moving average, or some similar approach?

Those generally generate a signal to decrease or increase your stock allocation based on the signals. And, yes, they both triggered a good "get out" and "get back in" signals for 2008/9. However, they're not perfect in any sense. Because you're dealing with moving averages, there is always a lag between when the trend starts and when the signal triggers. So if stock moves really quickly, the crash/rally could be almost over before a trigger happens. And there are plenty of examples of false triggers/short term small corrections where you would have been better off staying in than getting out. There are things you can do to minimize false triggers, but they don't work the same, historically, for all funds and they tend to increase the lag time for the trigger. So you find yourself tuning things to the nth degree to make it work. Then you stand back after all that tuning and realize that you've created an algorithm where you've datamined the snot out of things and you're on such a knife edge that it most likely won't work very well going forward.

Instead of the general "increase stock holdings/decrease stock holdings", you can also use the same idea as a rebalance trigger. Suppose stock is on roll - use the "get in" trigger to just let things ride until the "get out" trigger shows up and you then rebalance back to, say 60/40. Vice versa if stock is headed south.

I've built spreadsheets in the past to try out all of this. While there are good examples where I've seen short term rewards, in the long run, mainly I see a reduction in volatility and not much of a consistent increase in returns. Even more so for just using the idea as a rebalance trigger.

So I've set an AA I can live with using the same sorts of thoughts elsewhere in this thread regarding what would happen in a 30%-50% correction and use bands to rebalance.

All of that said, I still have a tracking spreadsheet for all of my funds where I track the signals - I just don't do anything about it....

Just as a point of reference, when setting our allocation we use a 50% equity decline assumption to test whether we can sleep well at night (and I believe we will sleep ok, but certainly not as well as these past few years, but we can live with that outcome! )

Thank you. I've been playing around with a spreadsheet to show larger drops in value and so far, it still looks like something I can sleep through. Will check with spouse after he's back in town.

Next I need to decide about BND versus more short terms bonds and also think about starting a cd ladder. We're approaching the 5 year to retirement window. As part of that, I think I should leave TDA and go to Vanguard. I think that would be the cheapest place to be for all this long term buy and holding.